After meeting with dozens of dairymen suffering financial distress, Walter sees issues that producers have likely never faced before.

By Riley Walter, attorney

In my last column, I commented on several observations about common characteristics in dealing with distressed financial situations. I knew then, as I know now, that the prior list was not by any means a comprehensive listing of the various observations I have had over the last couple of years as I met with in excess of 60 different dairymen suffering financial distress.

In this column, I want to amplify on some of my previous comments and lay out some other and additional observations. The point of these observations is to have dairymen think about issues that they have probably never really faced before.

First, too many of my distressed clients have “borrowed” from the government by not paying payroll taxes. While it is tempting to forego making the payroll tax contribution, this can have very serious consequences, as payroll tax obligations are generally not dischargeable in bankruptcy. If you are going to short someone, it should not be the government.

Second, in about 30% of the cases I have handled, the dairymen and/or the accountants have been using the incorrect name for their entity. In these modern times, many searches are done electronically. This requires that the exactly correct name be usedon various documents. There is a lot of difference between the Sanchez Dairy and the Paul Sanchez Dairy. There is a lot of difference between ABC Co. and ABC Inc. I am constantly amazed how often the name on the partnership agreement is different from the name used on the tax return, which is different from the name on the sign out in front of the dairy. Paying attention to detail is the hall mark of a good businessman.

A third, and really sad observation, is that so often the dairyman does not understand the concept of partnership liability. In at least three of my cases, the family has “given” a partnership interest to a young person. When the undigested feedstuffs hit the fan, those young people are often stunned to find out they have joint and several liability for all of the partnership debts. So often, they think that if they have a 5% interest they are liable for 5% of the debt. This is not the case. When this crisis is over, I am hopeful that a lot of dairymen will revisit the decision to be formed as a partnership.

A fourth and painful observation relates to income taxes. So often, people come to my office thinking that if they can get more cows to get more milk in the tank, their problem will be solved. However, in almost every dairy case that I have seen, the underlying issue -- if a liquidation is likely -- is income taxes. Folks just don’t seem to understand that the liquidation of assets can cause very significant income tax consequences, and those tax consequences are not necessarily dischargeable in bankruptcy. Considerable structuring and care needs to be taken to address income taxes in distressed situations.

Similarly, of late there have been a number of people who have come in to see me after they have liquidated the herd. This is a huge mistake. Some of them seem to think that, because they will have no assets, the creditors will not pursue them on the debt. This is rarely the case. Others failed to take into consideration the aforementioned tax consequence. While I do not blame anyone for wanting to save a few dollars on legal fees, this is a perfect example of being penny wise and pound foolish.

A fifth observation is that too many dairymen have been entirely relying on their cooperative retains for their retirement. It seems to stun the dairymen when I explain to them that those retains are not a protected qualified retirement plan. A qualified retirement plan can be protected from creditor claims but the retains cannot. In the future, I am hopeful that dairymen will be looking at the more modern retirement plan options available to them.

As one would glean from all of the observations in this column, one of my major observations is that at the very time when dairymen need financial help, they often skimp. Whether it is because they have not paid their accountant or cannot afford the bookkeeper matters not. This is an area that cries out to be maintained. Not having financial information during a period of financial distress will often lead to a liquidation that could be prevented if there were better financial reporting.

Another observation is the tendency to not keep the lender informed. Whether it is due to embarrassment, fear or just stress, too many dairymen are doing things that have an impact on the collateral of the lender without keeping the lender informed. As I often say to my clients, this is like an ostrich. However, remember if the ostrich has its head in the sand, it leaves only one target.

Last, I cannot resist observing that every one out of the 60 dairies I have seen is a good operator. Being a good operator, however, does not necessarily mean they are good financial managers. It is my observation that too many dairymen cannot give up day-to-day control of the cows and, instead, they forego financial management. Once this crisis abates, it is my prediction that lenders will lend only to good financial managers who have good budgets, good accounting and computer systems, and financial savvy. The days when it was enough to be “good with cows” is over.

Riley Walter is an attorney and founder of the Central Valley-based Walter & Wilhelm Law Group, a law firm specializing in agribusiness, reorganization and bankruptcy. Contact him at 559-435-9800 or RileyWalter@W2LG.com.

Last week, Rabobank’s Food & Agribusiness Research & Advisory (FAR) group released a report on the dairy industry titled “Dysrhythmia.”

The piece predicts that the well-known up-and-down cycles of milk pricing from the 1990s and early 2000s are, as we once knew them, history. Instead, the domestic dairy industry must now compete on a global level and, as such, is subject to more irregular prices in the marketplace. The news comes as another tough reality for an industry already struggling to recover from its massive hit in 2009.

Though in the midst of high input costs and irregular milk prices, some dairy operations are still managing to turn some profit. There are in fact survivors in the dairy industry, and the key to such survival lies much in the conversations that operators are having with their bankers – or for that matter, the conversations that operators need to have with their bankers.

The bottom line is that today’s dairy has to constantly focus on getting healthy, not just getting by. In years past, the attitude of dairy lending was a fairly direct approach – if an operation’s key financial data looked good, penciled out and fell within the right ratios, getting money was really more of a once or twice a year formality and process that came with just a short wait time.

Today, however, there are so many variables to a dairy’s success that bankers really have to act as advisors, working alongside operators to make certain that they’ll remain strong through the fiscal year.

Together with their banker, dairy operators can form strategic risk management plans, including identifying cost-saving tactics such as growing their own feed and hedging milk contracts; deciding to buy a dairy versus leasing; and establishing a burn rate analysis – a measure of how long the dairy can keep operating until it has to seek more financing. Above all, bankers want to see dairy operators maintain as much equity as they can in their business – with the idea that as long as an operation has equity, they can survive the tough months of negative cash flows.

The Milk Producers Council recently projected milk prices at $20.09 per cwt. for quota, and at $18.39 per cwt. for overbase. Total input costs for dairies are now averaging from $18.00-$20.00 per cwt. It’s easy to see that slim margins are here to stay, at least for the time being. Such margins are all the more reason why dairy operations have to be strategic about how they sustain their businesses. Today’s dairy operation needs to be looked at as a long-term investment with an investment advisor, i.e. banker, to help facilitate success and growth.

No matter who you’re banking with and how long or short of a history you’ve had with the bank, be sure to schedule an in-person meeting with your banker to make sure your dairy operation is on the right track for survival.

Rabobank, N.A. is a California community bank and a leading provider of agricultural financing and full-service banking products to California consumers, businesses and the agriculture industry. To learn more visit: www.rabobankamerica.com.